The impact of overdraft fees on consumers

More than three quarters of the largest U.S. banks allow their customers to overdraw their accounts when they lack sufficient funds in order to cover the transaction for a fee of $35, on average. The Consumer Financial Protection Bureau (CFPB) found the median transaction amount of purchases that resulted in an overdraft fee was only $24. Additionally, the CFPB study revealed that 18 percent of account holders pay the vast majority of all overdraft fees triggered by debit cards, checks, and automated clearing house electronic charges.

The banks’ overdraft fees cause financially vulnerable consumers to leave the banking system. Thirty-one percent of consumers without a bank account reported high or unpredictable account fees as one reason for not having an account, while 13 percent cited it as the primary reason for not having a bank account. Overdraft fees are unexpected and unpredictable because most banks do not give their customers notice of an overdraft until two or three days after the incident. In the meantime, the consumer continues to overdraw his or her account, incurring more overdraft fees. The CFPB study found that more than two-thirds of consumers would prefer that the bank decline the transaction rather than assess an overdraft fee.

The Pew Charitable Trusts recently released the findings of a study conducted on “heavy overdrafters,” those who incur over $100 in overdraft and non-sufficient funds fees. Pew conducted this survey out of concern for consumers because overdraft is high risk, in that it lacks the consumer protections that accompany other credit products. It found that most heavy overdrafters are: Millennials or members of Generation X; renters rather than homeowners; and those with low incomes. See below. Furthermore, overdraft fees consumed nearly a full week’s household income of heavy overdrafters.

Half of the heavy overdrafters incur six or more overdraft fees annually and 42 percent paid seven or more overdraft fees. Heavy overdrafters tend to have lower incomes than the rest of the U.S. population, with most reporting an annual household income of under $50,000. This means that overdrafts hit those who can least afford these predatory fees. Debit cards are the most common transaction method for heavy overdrafters, with the actual value of the debit card transaction being relatively low, around $24. Seventy percent of heavy overdrafters are employed.

Younger consumers in the Millennial generation may be more affected by these overdraft fees because they are more likely to use debit cards. Additionally, they may be more vulnerable to overdraft fees because many are managing finances independently for the first time. For example, many college students are opening their first accounts for financial aid refunds, and the outside companies that distribute these funds promote their own cards. The Department of Education has adopted rules banning the charging of overdraft fees on accounts used for student aid, which will go into effect this month.

The results of the Pew survey show that overdraft now serves as a form of short-term credit for many consumers. However, overdraft lacks the requirements that financial institutions use to verify customers’ ability to repay debt before extending credit and provide a reasonable time to repay, as well as limits on late fees.

Pew urges the CFPB to write new rules to ensure that overdraft programs are safe and designed only for infrequent and accidental occurrences. This could be achieved by limiting: the size of overdraft fees, the frequency with which they can be incurred, and overall cost. A limit of six overdrafts a year would save the 42 percent of heavy overdrafters, who incurred seven or more fees in the past year, a median of $210 annually. The Federal Deposit Insurance Corporation (FDIC) published guidance suggesting that banks should give customers a reasonable opportunity to choose a less costly alternative and decide whether to continue with fee-based overdraft coverage.

Frequent overdrafts are a financial burden, especially because the fees are oftentimes hidden and unpredictable. These fees cause many consumers to leave the banking system, with 13 percent of consumers without banking accounts citing overdraft fees as the primary reason, and forces them to use cash other alternatives, like payday loans with predatory interest rates.

Pew also suggests that the CFPB enact rules to limit the negative effects of overdraft fees and ensure that overdraft is not being used as short-term credit. It suggests that overdraft fees be reasonable and proportional to banks’ cost of covering overdrafts or to the overdraft amount. Financial institutions should charge no more than six small overdraft fees in any 12-month period that are proportional either to the banks’ cost of covering overdrafts or to the overdraft amount, and these fees should be limited to one per negative-balanced episode. If that limit is reached, then any further overdrafts should be covered under the rules for credit. Additionally, banks should post deposits and withdrawals in a fully disclosed, objective, and neutral manner that does not maximize overdraft fees.

NCL applauds Pew’s report and accompanying recommendations. Imposing these predatory fees on lower income Americans and Millennials who are just beginning to manage their own finances is unacceptable. We hope the CFPB takes action to minimize the impact of these odious charges.

In the meantime, we support the following strategies to avoid these exorbitant overdraft fees, or at least their frequency:

Set up text or email notifications that alert you when your balances are below a certain level.

Avoid opting out of overdraft coverage and simply have the card declined if there are insufficient funds.

Most banks offer to link a checking account to a savings or money market account, so that money transfers from the savings account to the checking account when there is not enough money in the checking account to cover the transaction. Opt in for this option if possible.

Finally, the last, and perhaps the easiest: Carefully monitor the balances in the accounts as well as individual transactions.